The Oakmark Fund increased 12% during the fourth quarter, bringing the gain for the calendar year to 37%. These robust results outpaced strong gains for the S&P 500 Index, which was up 11% for the quarter and up 32% for the calendar year. We are happy to report that the Oakmark Fund has outperformed the S&P 500 in three of the past four quarters. And for the calendar year, 41 of the Oakmark Fund’s holdings gained more than 30%, and the Fund ended the year at new high levels. We are very pleased with these strong results, but we continue to remind shareholders that these gains are well ahead of historical averages. Although stocks aren’t as cheap as they were a year ago, equity valuations are still near long-term average levels, so we expect broad market returns to also revert to more “normal” levels.

Our portfolio has been heavily invested in financial services, economically sensitive industrials and information technology. These three segments of the S&P 500 were among the best performers in the fourth quarter. We think our holdings in these areas remain attractively valued, and investments in these three segments account for almost 60% of the Fund’s assets as well as most of our incremental purchases during the fourth quarter. In addition to the initiation of new positions in Visa and Union Pacific Corporation (see below), our largest purchases during the quarter were in shares of Qualcomm, Aon and Intel. A position in Visa (V) was started after we gained greater confidence in new management and the shares became as attractively valued as Mastercard (MA).

Our best performers for the quarter were Forest Laboratories (FRX), FedEx and Liberty Interactive, and our worst performers were Cenovus, Applied Materials and McDonald’s. The Fund’s best three performers increased an average of 30%, which compares to an average decline of just 1% for the Fund’s worst three performers, and our portfolio weightings were significantly higher for the top performers. As value investors with a long-term horizon, we are happy to patiently wait for undervalued securities to appreciate toward our estimates of intrinsic value. Occasionally, we are pleased to see the value gap close more rapidly, which is what has happened with Forest Labs over the past three quarters. Forest Labs appointed a new CEO, who quickly introduced a substantial cost-cutting program and a more shareholder-friendly capital allocation strategy. These measures helped Forest Labs enjoy a 60% increase in stock price since January 2013.

As mentioned above, we started a new position in Union Pacific during the quarter.

Union Pacific Corporation (UNP - $166)(UNP)
Union Pacific is the largest freight railroad company in North America, operating primarily in the 23 states west of the Mississippi River. The company’s nearly 32,000 route miles link the Pacific Coast and Gulf Coast ports with the Midwest and eastern U.S. gateways, and it offers several corridors to key Mexican gateways. After decades of real rate decreases, a “rail renaissance” began around 2004 when the regulatory backdrop on pricing became more rail-friendly, service levels improved, and rising fuel prices helped rails compete with trucking. Since then, Union Pacific’s revenues have grown approximately 7% per year, and its operating margin has increased from the low-teens range to the low 30% range. We believe that these positive trends will continue, albeit at a slower pace, due to pricing power that exceeds inflation and moderate volume growth from an improving economy and a recovery in below-trend categories like housing, construction and agriculture. Moreover, the company’s profit margin can still improve further, and we expect Union Pacific to return the vast majority of its free cash flow to shareholders via share repurchases and dividends. We consider the stock to be attractively priced at only 12x our estimate of “normalized” earnings in 2015.

The S&P 500 Total Return Index is a market capitalization-weighted index of 500 large-capitalization stocks commonly used to represent the U.S. equity market. All returns reflect reinvested dividends and capital gains distributions. This index is unmanaged and investors cannot invest directly in this index.

The Oakmark Fund’s portfolio tends to be invested in a relatively small number of stocks. As a result, the appreciation or depreciation of any one security held by the Fund will have a greater impact on the Fund’s net asset value than it would if the Fund invested in a larger number of securities. Although that strategy has the potential to generate attractive returns over time, it also increases the Fund’s volatility.

The discussion of the Fund’s investments and investment strategy (including current investment themes, the portfolio managers' research and investment process, and portfolio characteristics) represents the Fund’s investments and the views of the portfolio managers and Harris Associates L.P., the Fund’s investment adviser, at the time of this letter, and are subject to change without notice.

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